HONG KONG, CHINA - India's economy is set to expand by 8.5% in the fiscal year to March 2011 (FY2010) but persistently high inflation and a rising rupee could undermine future strong growth, says the Asian Development Bank (ADB) in a major new report.
The Asian Development Outlook 2010 Update (ADO Update), released today, raised its gross domestic product (GDP) growth figure for FY2010 to 8.5% from ADB's April projection of 8.2%, while retaining its FY2011 estimate at 8.7%. Growth is being supported by robust investment, increased capital inflows, and stronger industrial output, buoyed by rising consumer demand.
The current account deficit forecast was also adjusted to 2.7% of GDP in FY2010, from 1.5% previously to reflect a sharp pickup in trade flows, with exports projected to grow by 18% in FY2010, and imports by around 20%.
At the same time, ADB raised its forecast for annual average inflation in FY2010 to 7.5%, up from 5% in April, warning that high food prices remain a near-term concern. It also noted that the rupee's appreciation by more than 11% in real terms between August 2009 and August 2010, poses an additional challenge for policymakers as they seek to maintain high growth while winding back the monetary and fiscal stimulus measures used to help the economy recover from the global economic crisis.
"A well-grounded, robust recovery will depend on the ability of the various policymakers to coordinate effectively amongst themselves to achieve macroeconomic stability, and striking the right balance amongst growth, inflation, and competitiveness objectives will be a delicate maneuver," says Jong-Wha Lee, ADB Chief Economist.
The report says that strong, well-timed monetary and fiscal stimulus policies helped cushion the impacts of the global downturn, and these are now being gradually removed with the Reserve Bank of India tightening monetary policy progressively this year.
Despite firming interest rates, growth in bank credit to the commercial sector has continued to recover, while a return in international investor appetite has seen a strong pickup in net capital inflows. A rise in industrial output supported by robust demand for consumer durables, a buoyant services sector, strong investment, and improving agricultural output after a flat FY2009 performance are also underpinning better economic prospects.
At the same time, high inflation and the rupee's sharp appreciation threaten to erode India's export competitiveness and its plans to further expand economic growth to 9% to 10% in coming years. Prolonged low interest rates in the major industrial economies could also speed up already high levels of short-term capital coming into the country, causing further tensions between inflation and the exchange rate.
The Reserve Bank of India is now projecting overall inflation to moderate to 6% by end-March 2011, which should provide some relief but if price pressures do not abate as expected the central bank will be hard pressed to intervene in the foreign exchange market to dampen rupee appreciation due to limited options for sterilization, the report says.
Other downside risks to growth forecasts are that the recovery in industrial economies could stall, or that global credit markets could experience a fresh shock.
Asian Development Outlook and Asian Development Outlook Update are ADB's flagship economic reports analyzing the economic conditions and prospects in Asia and the Pacific, and are issued in April and September, respectively.